Legislation Provides New In-Plan Roth Conversion Opportunity

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last updated 12/19/2013

Update: In December 2013, the IRS issued additional guidance regarding in-plan rollovers into Roth 401(k) accounts. By broadening the pool of eligible assets,
Notice 2013-74 provides participants with a greater opportunity to convert pretax dollars to Roth after-tax dollars. See the
SHRM Online article
New Guidance on 401(k) Roth Conversions.

The
American Taxpayer Relief Act signed into law on Jan. 2, 2013, includes a significant new opportunity to perform “in-plan” conversions of pretax dollars to Roth (after-tax) dollars, regarding funds held in defined contribution retirement plans such as 401(k) plans, 403(b) plans and governmental 457(b) plans.

Plan sponsors who previously considered but rejected implementing an in-plan Roth conversion feature for their plans due to the modest benefit previously available to employees may now want to reconsider whether such an approach makes sense in light of the greater benefits provided under the new law.

For plan years beginning after Dec.31, 2012, employers will have the option, but not the obligation, to amend their defined contribution retirement plans to add (or expand) the new conversion feature. An in-plan Roth conversion of pretax (non-Roth) plan assets causes the converted amounts to become taxable in the year of the conversion, but allows any future qualified distributions of the converted amounts, along with any accumulated earnings, to be provided tax-free to the participant.

Prior to the passage of the act, in-plan Roth conversions were available on a more limited basis. Such conversions were only permitted for amounts that participants were otherwise eligible to withdraw. In general, this meant that the amounts eligible for conversion were limited to funds the participant had rolled over from a prior plan or amounts the participant could withdraw upon reaching age 59½ or termination of employment, unless the plan otherwise allowed for in-service distributions. This resulted in a relatively small pool of potential participants and assets that were eligible for the in-plan Roth conversion.

Under the new, expanded conversion right, an eligible plan that permits regular non-rollover Roth contributions could allow participants to convert
any pre-tax vested amounts to Roth amounts within the plan—whether or not participants are eligible to withdraw such amounts. By broadening the potential assets eligible for conversion to include previously ineligible amounts, such as employee elective deferrals and employer matching contributions, the new law provides participants with a much higher potential base from which they can choose to convert to after-tax dollars.

Additional guidance will be needed to confirm how the expanded conversion right will be carried out. It is likely that the new conversion right will operate in the same manner as existing in-plan Roth conversions under
IRS Notice 2010-84, but this had not been confirmed by the IRS.

Members may download one copy of our sample forms and templates for your personal use within your organization. Please note that all such forms and policies should be reviewed by your legal counsel for compliance with applicable law, and should be modified to suit your organization’s culture, industry, and practices. Neither members nor non-members may reproduce such samples in any other way (e.g., to republish in a book or use for a commercial purpose) without SHRM’s permission. To request permission for specific items, click on the “reuse permissions” button on the page where you find the item.